WILL GREECE GO BANKRUPT and KILL the EURO? the Benefits and Cost of Helping Greece
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WILL GREECE GO BANKRUPT AND KILL THE EURO? The benefits and Cost of Helping Greece HERBERT GRUBEL* Fecha de recepción: 30 de septiembre de 2012. Fecha de aceptación: 19 de diciembre de 2012. Resumen: Este artículo compara los beneficios con los costes derivados del salvamento griego, llegando a la conclusión de que los beneficios superan claramente a los costes. También se analizan las causas del problema, el papel de las sociedades de rating y la euforia previa especulativa, efectuán- dose unas consideraciones sobre el futuro del euro y del orden financiero internacional. Palabras clave: Bancarrota Griega, Euro, Estadísticas en Grecia, Credit ratings. Clasificación JEL: F33, F34, F36, F55, G15, G24. Abstract: This paper compares the benefits to Greece, the Euro zone and the rest of the world arising from policies that prevent a Greek default and exit from the Euro with the costs of preventive policies. It concludes that the * Professor of Economics (Emeritus), Simon Fraser University. Senior Fellow, The Fraser Institute. Note: I thank participants at the Athenian Conference in Thessaloniki, Greece, July 1, 2012 and at the 75th Anniversary Conference of the Hong Kong Polytechnic University in Hong Kong on November 14, 2012 for comments on an earlier version of this paper. The analysis has also been influenced by discussions of the issues at the annual meeting of financial experts organized by Robert Mundell in Siena, Italy in July 2012 and at the Mont Pelerin Society meetings in Prague, Czech Republic in September 2012. I also gratefully acknowledge helpful comments on an earlier draft by George Bitros, Richard Cooper, Max Corden, Nick Kaiser, Wolfgang Kasper, Antonios Koumpias, Helmut Mayer, Claire Morrissey and Richard Pomfret. Procesos de Mercado: Revista Europea de Economía Política Vol. X, n.º 1, Primavera 2013, pp. 65 a 90 66 HERBERT GRUBEL benefits exceed the costs, though unpredictable politics and nationalist aspirations may prevent the adoption of the rational policies. The paper also considers the causes of Greece’s problems: the failure of lenders to ask for a proper risk premium on the country’s bonds; Greece’s publication of false economic data; the failure of credit rating agencies to down-grade its bonds; the global financial euphoria and supply of liquidity that made lenders disregard traditional standards in all their dealings. The paper recommends policies to ensure the proper functioning of financial markets to prevent future crises. Key words: Greece bankruptcy, Euro survival, Greek statistics, Credit ratings. JEL Classification: F33, F34, F36, F55, G15, G24. This paper discusses first the benefits that accrue to Greece, other Euro zone countries and the world from policies that avoid Greece’s bankruptcy and exit from the Euro. The second part outlines the cost and nature of these policies and presents a benefit/cost analysis suggesting that it is rational to continue with these policies. Also discussed is the possibility that unpredictable political forces threaten the use of these rational policies. The final part considers the causes of the Greek crisis in order to find po - licies that would avoid future problems with Euro zone countries facing severe and persistent fiscal imbalances. A summary and conclusions closes the paper. I BENEFITS OF GREEK RESCUE POLICIES Policies successful in avoiding Greece’s bankruptcy and exit from the Euro would bring a number of benefits.1 The first arises from the avoidance of financial turmoil that accompanies expec- tations of bankruptcy and currency devaluation. This turmoil would cause bank deposits and other liquid assets to be shifted 1 For a more general discussion of benefits derived from the adoption of the Euro by all of the member countries of the currency union see Huerta de Soto (2012). WILL GREECE GO BANKRUPT AND KILL THE EURO? 67 abroad, leading to the breakdown of the entire banking system, recession and unemployment. According to data from the central Bank of Greece, deposits worth over 70 billion Euros, which is equal to about 35 percent of the country’s GDP in 2012 have been withdrawn from the Greek banking system since 2009, with 25 billion Euros deposited abroad and the remainder hoarded in cash.2 The second set of benefits involves the avoidance of a recession and unemployment that would accompany the uncertainty around the determination of the exchange rate for the new drachma; the size of the haircuts creditors can expect on their Greek bond hol- dings; the risk of creditors using foreign courts to seize Greek assets abroad; the magnitude of inflation certain to arise and its effects on the levels and distribution of incomes, social programs and taxation. Third, the avoidance of Greece’s bankruptcy and exit from the Euro would allow the retention of the gains brought joining the currency area, such as lower transactions costs in foreign exchange markets and the resultant increased trade and capital flows and, most important preventing its politicians from buying votes through the provision of benefits to interest groups while ordering the Bank of Greece to finance the resultant deficits by printing money.3 These vote-buying practices had resulted in a long his - tory of Greek political business cycles involving inflation, deva - luations,4 booms and recessions accompanied by unemployment and low economic growth.5 They ended with the adoption of the 2 This information has been provided to me in private correspondence by An - tonios Koumpias, who is a student in the Department of Economics, Duke Univer - sity. 3 These practices are explained in Public Choice Theory, the development of which owes much to Nobel laureate James Buchanan (1967) and Mancur Olson (1971). 4 Following a hyperinflation in the wake of the Second World War, the exchange rate of the drachma against the dollar was fixed at 30. In 1998, the rate was 304. These data were found at (http://greekcurrency.awardspace.com/greek-currency/history.htm) and (http://www.tradingeconomics.com/greece/inflation-cpi). 5 For an account of Greece’s modern economic history see Andritsoyiannis (2012) and Bitros (2012). 68 HERBERT GRUBEL Euro because Greek politicians were unable to get the European Central Bank to monetize its deficits.67 While the benefits noted above are impossible to document empirically, the fourth benefit from avoiding Greece’s bankruptcy and exit from the Euro is evident from Figure 1.8 In expectation of the adoption of the Euro in 2000, during the 1990s the premium over German bond rates for the sovereign bonds of Italy, Spain, Ireland and Portugal narrowed because of the widespread belief that the use of the Euro would prevent political business cycles and eliminate all exchange risks. The same reduction in the risk premium on Greek bonds developed after 1998 when it became increasingly expected that the country would join the Euro zone. However, as the graph shows, after the global crisis in 2008 the risk premiums on all sovereign bonds increased again to levels above those that had existed before 2000. The premium for Greece has become the largest by far. 1. Benefits to Euro zone and rest of the world countries All member countries of the Euro zone would also benefit from the prevention of Greece’s bankruptcy and exit from the Euro. The economies of Spain, Italy, Portugal, Ireland and some other countries with large fiscal imbalances would not be contaminated 6 For reasons to be discussed below, while the adoption of the Euro did eliminate the political business cycle, it did not eliminate the deficits resulting from the vote buying practices, as had been predicted by economic theory and noted in my study of the benefits and costs of creating a North American Monetary Union (Grubel 1999): «the union agreement..limits the ability of member countries to incur large and persistent budget deficits». (p. 15). 7 However, George Bitros pointed out in a private email that: «EU assistance played an important role since 1981 in glossing over the deficit spending behavior of all Greek governments. This “manna from heavens” helped all governments build a clientelist state on the perception that the EU largesse would continue ad infinitum. That is why I maintain that the EU leadership and authorities are partly responsible for what happened in Greece.» This conclusion is based on analysis contained in his forthcoming book Creative Crisis in Democracy and Economy in (2013), Axel Springer Verlag. 8 This figure is from Pomfret (2011). WILL GREECE GO BANKRUPT AND KILL THE EURO? 69 FIGURE 1 29 27 25 23 21 19 17 15 13 11 9 7 5 3 1 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 Germany Greece Italy Portugal France Ireland Spain Source: BofA Merrill Lynch Global Equity Strategy, Bloomberg. by the spread of speculation in the wake of events in Greece and would avoid capital flight accompanying speculation about their fiscal conditions and possible exit from the Euro. At the same time, countries with strong fiscal positions, like Germany, would not have to deal with the problems speculative capital inflows would present them with. Avoided would also the risk that the collective resources assembled to aid Greece would almost certainly be insufficient to rescue these larger countries from speculative flight from their financial instruments. If the Euro were replaced by a return to national currencies all of the short-run uncertainties mentioned above in the discussion of Greece’s problems would arise. In the longer run, the micro- economic benefits from the currency union would be lost: savings from currency transactions and hedging; increased trade and ca pital flows and productivity and lower interest rates. Several of the Euro member countries would again suffer from their po - liticians’ return to vote buying practices and the resultant business cycles.